Wednesday 26 October 2016
Is the Aussie equity market efficient?
Wednesday 26 October 2016
The Australian equity market has become a stock picker’s paradise over the past few years, helping a number of Australian fund managers deliver significant alpha to clients. We think one of the reasons for these increased opportunities is that the broad Australian equity market is becoming less efficient. This may sound counter intuitive in this increasingly socially connected world, but our data suggests two underlying causes.
The first is a decline in research coverage of Australian companies and the second is an increasing flow of capital towards indexing. Both trends have created tailwinds for active managers.
Inefficiencies in equity markets
Theory suggests that the more information that is analysed, published and reviewed by market participants, the more efficient markets will become, as all ‘relevant information’ is incorporated into a share price. In general, therefore, a manager investing in a universe with poor research coverage is likely to have a greater opportunity to add more alpha than a fund manager operating in a highly researched stock universe. Mercer data (below) illustrates the point by comparing alpha between Australian large and small cap investment managers. Active managers in the under-researched small cap market have delivered significant excess returns over the last 10 years.
Median Australian large and small cap managers*
Source: Mercerinsight.com *10 years to 31 August 2016 according to Mercerinsight.com. Benchmarks Large cap: S&P/ASX200 Accumulation, Small Caps: S&P/ASX Small Ordinaries Accumulation. Median manager based on the managers included by Mercer in the Large Cap and Small Cap universes.
The decline of published company research
Since the Global Financial Crisis, sell side research firms have encountered declining profits driven by lower revenues. As low cost competition, driven by technological advances and algorithms have eroded sell side research firm’s pricing power. Over time, we have observed sell side research firms have reacted to declining profits by:
- Employing fewer analysts – our data, captured over the past 10 years shows a 14% decline in number of sell side analysts publishing earnings estimates.
- Increasing stocks per analyst – giving each sell side analyst more stocks to cover which decreases the depth and understanding of each company. Over the past decade, sell side analysts have increased their stocks under coverage.
- Hiring more junior researchers – as senior analysts leave, firms tend to replace them with junior analysts that cost less to employ, but are far less experienced.
The charts below highlight the effects of this phenomenon over the last decade. More companies are being covered by fewer analysts, resulting in a 40% increase in stocks covered by individual sell side analysts. This has led to the time spent by each analyst on individual company research declining.
Capital flows into indexing
The second trend and one we are witnessing both globally and at home in Australia, is that investors are increasing their allocation to passive strategies.
The trend of asset allocation towards indexing offers increased opportunity for active managers. In general it means there is relatively less money chasing mispriced securities, as investors choose passive approaches to their investment decisions. Importantly, the trend toward passive management is also taking place in the institutional investment market – both domestically and globally.
The decline in research coverage of Australian companies and the increasing flow of capital towards indexing has resulted in the Australian equity market becoming a stock picker’s paradise. We expect these tailwinds to continue for the foreseeable future and in our view, the best way to take advantage of these trends is through active management. For us, it’s a good time to be an active investment manager in Australia.
For financial advisers only – not for distribution to retail investors
This information has been prepared by Macquarie Investment Management Australia Limited ABN 55 092 552 611 AFSL238321, the issuer of units in the Macquarie High Conviction Fund for general information purposes and does not take into account the objectives, financial situation or needs of any person. Before making any financial investment decision or a decision about whether to acquire, or continue to hold an investment in the Fund, a person should obtain and review the Product Disclosure Statement for the Fund and also seek independent financial, legal and taxation advice.
Future results are impossible to predict. This report includes opinions, estimates and other forward-looking statements, which are, by their very nature, subject to various risks and uncertainties. Actual events or results may differ materially, positively or negatively, from those reflected or contemplated in such forward-looking statements. Forward-looking statements constitute our judgement as at the date of preparation of this report and are subject to change without notice. This information is not a recommendation to buy, sell or hold any financial product, security or other instrument.
No representation or warranty, express or implied, is made as to the suitability, accuracy, currency or completeness of the information, opinions and conclusions contained in this document. In preparing this document, reliance has been placed, without independent verification, on the accuracy and completeness of information available from external sources. To the maximum extent permitted by law, no member of the Macquarie Group nor its directors, employees or agents accept any liability for any loss arising from the use of this document, its contents or otherwise arising in connection with it.
Other than Macquarie Bank Limited (MBL), none of the entities noted above are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities, unless noted otherwise.